Are Hard Pegs Ever Credible in Emerging Markets? Evidence from the Classical Gold Standard

Using a new database of weekly sovereign debt prices of paper currency and pound sterling (or gold) denominated debt, we identify the currency-risk component of sovereign yield spreads for nine of the largest emerging market borrowers for the period 1870-1913. Five years after a country joined the gold standard, paper currency bonds traded at significantly higher interest rates (more than 400 basis points on average) than a country’s foreign currency debt denominated in pound sterling. Investors also expected exchange rates to fall by roughly 20 percent even after emerging market borrowers had joined the gold standard. The presence of persistent positive currency risk premiums long after gold standard adoption suggests that hard pegs for emerging market borrowers may never be fully credible.

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